Clock Ticks as Market Hopes for Euro Zone Plan

Euro zone leaders need to come up with a clear, substantive plan for solving Europe's debt crisis, and they've got to do it soon.


More than three weeks ago during the International Monetary Fund, World Bank meetings, UK Chancellor of the Exchequer George Osborne suggested that euro zone leaders had just six weeks to come up with a substantive plan to solve the area’s crippling debt crisis. That deadline is the G20 leaders summit in Cannes on Nov. 3. The German Chancellor Angela Merkel says there's no "big bang" miracle cure, but the market’s hopes that Europe is edging toward a solution have buoyed stocks. The FTSE has rallied nearly 8 percent since the Washington summit, and the DAX and CAC 40 have done even better, up nearly 15 percent in the last three weeks.

That rally has been based on the broad outline of a plan centered around three things: a more credible restructuring of Greek debt, including private sector involvement of 50 percent or more; a big recapitalization of banks, and devising a scheme that leverages the firepower of the European Financial Stability Facility (EFSF) bailout fund from 450 billion to between 2 and 3 trillion euros to protect the debt of other peripheral countries. On top of this, there will also need to be measures to try and boost growth.

But that's the easy bit, because at the back of every investor’s mind is the thought that we could be setting ourselves up for a big fall. To avoid massive disappointment, leaders will need to go a lot further than merely announce a plan. They will need to provide exact details on how each component will work. They will have to prove that any plan for Greece really is sustainable. They will have to show that new capital rules for banks won't be achieved through the shrinking of balance sheets, which would cripple credit and cause a fresh recession. And they will have to devise a plan for the EFSF that avoids potentially huge political headwinds.

And lest they should dither, former Lehman banker Larry MacDonald's note reminds us what's at stake. In the worst-case scenario, the euro breaks up, and according to HSBC, that could mean a repeat of the Great Depression. The reintroduction of national currencies and legal ambiguities would rattle markets. Peripheral nations may suffer hyperinflation as their currencies plunge, while the core economies would be hammered by surging exchange rates.

If Greece left the euro first, UBS suggest its new currency would drop 60 percent and that local borrowing costs would jump at least seven percentage points. The cost in that country would be as much as 11,500 euros per person in the first year.

If Germany quit the euro, UBS says, its new exchange rate would probably surge 40 percent and interest rates two percentage points. Banks would require recapitalization, and trade would slide by 20 percent. Each person would lose as much as 8,000 euros in the first year.

The pain would probably spread. Credit Suisse reckons the S&P 500 would tumble to around 750, and corporate earnings would slide as much as 45 percent. They have assigned a 10 percent probability to a euro breakup.

No pressure then. The clock is ticking.